I want that cap "for free" by incorporating it in the very definition of the contract. Both for futures and for options. This would effectively change the game by not allowing black swan events anymore, on the respective instruments.
>> Do you think it will be free in the pricing of an OTC pair? I'm not referring to OTC strategies which involve several current options. I mean a new type of instrument for *single* options or futures, which is perfectly equivalent to the current contract, *with* the addition of the cap.
I'd say yes. Your losses are capped at the difference between the current price / strike + price of the option. And you are capping it. Total loss on the trade can't be any more.... capped.
Say I'm selling you such an OTC option on GM (currently priced at $36.30). It'd be an ATM call, striked at $36 and under the current condition I'd price it at $1.5. On a lot size of 100, that'd be $150 on your side (the buyer). If the spot price goes up to $72 you receive from me up to ($72 - $36) * 100, so up to $3600 for that price you payed me. If the spot goes to $200, than you only receive $3600. That simple.
This is a perspective of the seller. As a buyer you may have a different perspective, of trying to rip off the other part, but as a buyer I'm never looking into that. 2x the strike price is practically "never" under a normal distribution assumption, and 99% of the times and of the market plays under this assumption.
This capping would greatly increase the liquidity on the long run since it would allow the retail sellers like me to entry the market. I'd also need capped CFDs or futures to be able to delta-hedge my sells but nevertheless, the required capital can be computed deterministically. As long as I'm guarranteeing I've got contract_size x $strike_price amount in my account, noone gets to sell their house to cover the losses.
By the way, I see Robert Morse has some connections with Lightspeed Trading, so maybe he can offer a more "broker" view on these things. Currently I have an account with Interactive Brokers and use their API for getting marketdata and sending orders but I write my own stuff. The greatest problem I have is the unlimited loss nature of the current exchange-traded options and CFDs or futures (which I use for hedging). So I wanna use these "capped" type of instruments, in order to garrantee I can't go bankrupt (not only lose my account but also my house). And in fact, capping at a strike price swing is enormous. In quant talk, predicting anything beyond two standard deviations of the current ATM volatility has the same reliability as reading in chicken entrails. So what I truly want is cap things at 2x standard deviations with respect to the end of day at-the-money implied volatility. And I wanna either use a broker who already has that or develop (and price) the stuff myself for a broker who's interested in it. I have several brokers in mind, but most important thing is convincing "the market", that is you guys, that it's better to trade this stuff rather than the broken exchange stuff. The exchange stuff and it's unlimited loss nature creates crysis after crysis where only the small guys like us lose their houses, because the "too big to fail" fuc*ers never pay in full. Never pay even close to full, so they can afford to keep the charade going since they aren't the ones paying, but the little people.
Why is a simple option spread not sufficient for your purposes? And while, yes, such products may exist in OTC space, if you think that you won't be paying for this optionality through the nose, you may want to think again.
>> Why is a simple option spread not sufficient for your purposes? It's complicated to use compared to plain capped option and spot instrument (capped CFD). >> And while, yes, such products may exist in OTC space, Well, I suspect too the *may* part, that's what I'm trying to find out here. >> if you think that you won't be paying for this optionality through the nose, you may want to think again. That's a great opportunity for being more competitive than those guys!